If you are in your 20’s or 30’s there is a good chance that you have not yet put much thought into your insurance planning. Maybe you said yes to the insurance on your mortgage or maybe you have benefits through your employer. While this may be a start, it is rarely the best solution for young and healthy adults. In fact, an individual policy could potentially offer you better protection at a lower cost. There’s one catch…you need to be healthy to qualify for the coverage.
Insurance needs are different for someone in their 30’s compared to someone in their 50’s. If you have met with an insurance advisor who only showed you a permanent plan (Whole Life or Universal Life), maybe as a very attractive investment vehicle, I would strongly encourage you to obtain a second opinion to know what other options you have.
Should I Buy Permanent Insurance?
First question should be, what’s the purpose of the coverage? Term insurance is for “IF” you die where permanent insurance is for “WHEN” you die. While you are young, you would buy insurance purely for protection to provide for your family in the event of a premature death, this is typically best handled by a term insurance policy. It is smart to also consider Disability and Critical Illness insurance as the financial impact of being disabled could be the same or even higher than a premature death. Lastly, you would need to make sure that you start planning for your retirement early in life by contributing a fixed amount towards your retirement savings.
The coverage for permanent insurance is much more expensive than term insurance, therefore it may prevent you from putting dollars towards proper insurance and/or investing for your own retirement. It’s important to make sure that you take care of your immediate current needs before considering life insurance for your future. If there is still budget left after you have properly covered yourself in the event of death or disability while still saving towards retirement, then you could consider a permanent plan as well to at least take care of your final expenses.
As you age, your needs/wants will evolve and you will look at insurance as an overall part of your estate plan. Many permanent plans are designed to cover capital gains or transfer wealth to the next generation in the most tax-efficient manner. Hopefully by this point, your mortgage is paid off and you no longer depend on your income meaning the need for both Term Insurance and Disability Insurance are likely no longer needed. In addition, you kids may now be done school, married and financially independent. This will free up the cash flow allowing you to invest towards a permanent plan.
Can’t I Use Life Insurance for Retirement Income?
Some permanent insurance has cash values that grow inside the policy. In most cases, you should maximize your RRSP and TFSA’s before investing into an Insurance Policy. In addition, you should have a need/want for the insurance itself as you will also be paying for the actual cost of insurance.
- With an RRSP, your contributions are tax-deductible earning you a tax refund each year you contribute. The money grows tax-free until it’s time for you take the money out. When you withdraw money from an RRSP, it is fully taxable.
- The TFSA does not give you a tax break on contributions, but it does grow tax-free and you do not pay tax on withdrawals either.
- With Life Insurance, you do not get a tax break on contributions, but it does grow tax-free. At time of withdraw, you will pay tax based on the capital gain of the policy. This gain is calculated by the difference in the Cash Surrender Value (CSV) and the Adjusted Cost Base (ACB). The ACB is a complex calculation with multiple factors that can come into play. Typically, we are looking at the difference in the cumulative premium paid into the policy less the Net Cost of Pure Insurance (NCPI). However, if you pass away, the beneficiary will receive the proceeds tax-free. There is potentially an option to take out a collateral loan against an insurance policy, however, this is not advisable as a primary source of retirement income due to the nature of the risks of doing so (change in loan requirements, change in tax laws, general anti-avoidance rules, financial institution asking for more collateral or force surrender on insurance policy to repay loan).
Life insurance can be used as an investment, but the real benefit is when those investment dollars are intended to go to a beneficiary as those proceeds are paid out tax-free upon your death. However, in the event that you need access to additional capital, you do have options in which you can access the cash value of your policy.
What about the Long Term Savings by Buying Permanent Life Insurance when I am Young?
While it’s true that there are long term savings by going with a permanent plan today, the high cost may prevent you from having proper protection or if you are in a financial crisis, you may be forced to cancel the coverage. Insurance is a great way to transfer wealth over from one generation to the next, but you need to ensure that you take care of yourselves first when it comes to proper financial planning and retirement.
Another thing to consider is how time will impact the value of the dollar over time. In 1985, a dozen eggs cost $1.37. Today, a dozen eggs cost $3.35. This means that over 20 years, the cost of eggs has increased by 245%. Using these metrics, a dozen eggs would cost roughly $20.00 in 40 years. Keep in mind, as cost of living increases so should your income. This just illustrates that a $200,000 policy today will not hold the same value in 40 years and will very likely be worth much less. In fact, using the above factors, $200,000 in 40 years is like having $33,477 today when it comes to purchasing power. If Canada can keep the inflation rate down to 2.5%, then $200,000 would still only be worth $74,476 in 40 years. Also keep in mind that even though premiums will be more expensive in the future by waiting to buy permanent insurance, spending $400 in 40 years is like spending $150 today when you factor in inflation.
Why would I ever need permanent insurance?
I think the better question would be why would I ever WANT permanent insurance? Permanent insurance is a wonderful tool to help you achieve several goals such as:
- Pay for final expenses
- Transfer wealth to next generations
- Provide a legacy for your children or grand children
- Pay for capital gains from sale of business or assets
- Diversify an investment portfolio
- Donate to a charity
Here is a great example how insurance can help with transferring the family cottage to the next generation. Let’s say someone purchased a cottage for $200,000 and the value increased to $700,000 by the time it is to be passed on to the next generation. Based on a 40% marginal tax rate, the estate would be stuck with a $100,000 tax liability that would need to be paid.
A common means to cover capital gains tax on a cottage is to purchase a life insurance policy which will help to avoid the forced sale of estate assets upon death. However, life insurance should be considered earlier in life as the insurance does become more expensive as you get older, and may become prohibitive in your senior years. You could also use life insurance to equalize the estate if one or more child does not want to keep the cottage and would prefer to split the proceeds of the sale. Based on the above example, the $100,000 tax-free payout would cost a 60 year old couple roughly $135 per month to purchase a joint-last-to-die permanent policy. This is a small price to pay to have the peace of mind in knowing that their heirs will not be left with a tax liability and the cottage can be passed along as they wished.
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By Jeff Romansky
CHS, CPCA Principal, SecurePlan Insurance Solutions
Jeff started his insurance career in 2006 by helping hundreds of insurance advisors grow their business by providing them with comprehensive advise, consultation and training. After nine successful years, he decided to take his knowledge and start his own practice to ensure his clients are getting the best advice. SecurePlan is an insurance advisory and consulting firm specializing in group benefits as well as individual insurance benefits for professionals, executives and owner-managed businesses.